Generic strategies and congruent organisational structures: Some suggestions

GENERIC STRATEGIES AND CONGRUENT ORGANISATIONAL STRUCTURES

Generic Strategies and Congruent Organisational Structures: Some Suggestions DAVID FAULKNER, Lecturer in Strategic Management, Cranfield Insfit’ufe of Techno2og-y; CLIFF BOWMAN, ~cf~~e~ in Sfyfffegic Mu~~ge~e~f, C~un~e~d ~~sfif~fe of ~ec~no~og~

Michael Porter’s four generic strategies for achieving competitive advantage can be condensed into two - low cost ieadership and differentiation. David Faulkner and Cliff Bowman argue that, unlike Porter, it is false to choose between these two orientations. Only the low cost strategy with internal success criteria establishing differentiation and delivering at low cost, and thus able to achieve what the authors call ‘external success criteria’ of both Cheaper and Better, will gain sustainable competitive advantage.

The firm’s organisational structure can be adapted on a value activity basis rather than an overall business unit Ievel to realise this proposed strategy,

Introduction Michael Porter‘s theories on generic strategies and appropriate organisation structures raise a number of issues. This paper highlights some of these issues by first setting out some of the problems with the Porter generic strategy concepts, and then suggests a way in which thinking could progress in relation to these concepts.

Porter’s Generic Strategy Concepts Porter suggests that there are only four basic generic strategies for achieving sustainable competitive advantage, namely Broad Scope Differentiation, Focused Differentiation, Broad Scope Cost Leadership, and Focused Cost Leadership (Porter 1985). These are normally illustrated in the box form shown in Figure 1.

He further suggests that for best performance, a business unit or SBU should generally select only one of the four generic strategies, and should adopt an organisation structure that best reflects the requirements of the chosen strategy (Porter 1985). Thus a Cost

494 EUROPE IA1 N MANAGEMENT JOURNAL Vol 10 No 4 December 1992

Leadership strategy would require an ‘efficient’ organisation, and a Differentiation strategy may well need a ‘flexible’ one.

The generic strategy concepts have been subjected to a limited amount of empirical testing (Dess and Davis 1984; Miller and Friesen 1986; White 1986; McNamee and McHugh 1984), which provides some support for the theory. There have also been a number of theoretical contibutions which have criticised, in particular, the problem of being ‘stuck in the middle’ through attempting to pursue Cost Leadership and Differen- tiation simultaneously (Karnani 1984; Murray 1988; Hill 1988; Cronshaw, Davis and Kay 1990).

In addition to these academic critiques, our experience of trying to work with Porter’s concepts with practising managers has revealed to us some further problems and limitations to the approach. To attempt at the outset to shed light on these problems it may be valuable to unravel the Porter generic strategies linguistically. Firstly, the four strategies condense into three by being restated as Cost Leadership, Differentiation, and Focus (Porter 1985). From here it is a short step to restate them as two, namely Cost Leadership and Differentiation, but applied either to a broad market segment or a narrow one. This is merely a semantic argument, but it serves to highlight the fact that Porter’s generic strategies are not all the same category of statement, in that Cost Leadership and Differentiation are ostensibly about how to compete, and Focus is about where to compete. We shall set out some of the problems with the Cost Leadership and Differentiation strategies below.

Cost Leadership 1. Cost Leadership is an objective for an SBU that is likely to mean that, when a sale is made, it will be a relatively profitable one, and if a price war develops, the cost leader is likely to win. However, Porter argues


Source of Sustainable Competitive Advantage

Differentiation I

Broad Differentiation Overall Cost Leadership

Figure 1 The Porter Generic Strategies

that the cost leader charges average prices and offers average quality - in other words, as far as the consumer is concerned, the cost leader’s offerings are indis- tinguishable from those of the industry’s average player. Cost Leadership, as such then, is an attribute that is quite invisible to the customer, and cannot therefore of itself accord sustainable competitive advantage, as it cannot ‘make the sale’. It may therefore be difficult, if average prices are charged, to achieve the volume to gain maximum scale economies and experience benefits to remain the cost leader.

2. So in order for Cost Leadership to lead to superior profitability, it is necessary, according to Porter, for the firm to charge industry average prices (Porter 1985). However, if the firm offers lower prices than the industry average to ‘make the sale’, there is no guarantee that lowest costs would lead to above average profitability.

3. Cost Leadership is often associated (Porter 1980; 1985; 1987; Skivington and Daft 1991; Miller 1988; Karnani 1984) with competing in low price segments, e.g. Porter cites Hyundai in the car market as a cost focuser.

4. Furthermore, empirical studies have identified several cost leaders in the same industry (Dess and Davis 1984; Miller and Friesen 1986). As this is logically impossible, these researchers must be referring to cost-oriented firms rather than cost leaders.

5. Operationalising a Cost Leadership strategy requires the management to know their competitors’ costs. This information is rarely freely available, and the problems of obtaining even rough estimates of competitors’ costs can be immense.

6. Most management teams are more comfortable looking inside their organisations, rather than finding out about suppliers, buyers and competitors. Cost

Leadership, simply interpreted, provides them with a justification for their inward focus, which may well not be what the business needs.

These are some of the principal problems with the Cost Leadership strategy.

Differentiation Differentiation, however, is by definition (Porter 1985) visible to the customer, and can lead to high perceived use value, and hence competitive advantage. But this will only be achieved if there is precise understanding of what is valued by the customer, and the decision on where to compete is judiciously chosen. There are problems with Porter’s concept of the Differentiation strategy:

1. There is confusion as to whether ‘Differentiators’ gain advantage through premium pricing or through increasing market share at average prices. Porter, for instance, gives some examples of premium pricing differentiators, and others of average pricing differentiators (e.g. American Airlines, Porter 1988).

2. Differentiation is often confused with competing in high priced segments e.g. Mercedes in the car industry. It is not obvious over whom Mercedes sets premium prices. It certainly does over Nissan, but does it premium price over BMW? Is it strategically relevant that Mercedes charges higher prices than Nissan, if they are not competing for the same customer?

3. There is no theoretical reason why differentiators could not also be the lowest cost producers in their segments, if their superior offerings lead to increasing market share, translatable into scale and experience economies. In this case the successful differentiator should also be the lowest cost producer. Porter would argue that to attempt to be both a differentiator and the lowest cost producer would lead to organisational conflict (the well known problem of being ‘stuck in the middle’, Porter 1985). However, his arguments are not wholly convincing, and are addressed further later in this article (see also Murray 1988).

To summarise, there are a number of theoretical and practical problems with Porter’s generic strategy concepts which have caused a degree of confusion in strategic management thinking. In the next section we outline an alternative approach to competitive strategy which attempts to remove some of the points of confusion.

A Sustainable Strategy The fundamental generic options, as they are visible to the customer, are to provide products and services that are perceived by customers as being:

(1) better than the competition, but are offered at similar or sometimes higher prices;

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(2) as good as the competition, but at lower prices; (3) better than the competition and at lower prices;

and clearly (3), if it can be done, beats either (1) or (2).

These are the only potentially successful possible competitive strategies that can be perceived by the customer, and hence influence the sale, at this meta level of generalisation.

This statement of the strategic options avoids some of the problems with Porter’s framework, since all three strategies are concerned with the same type of action, i.e. action that is visible to the customer, and thus actions that will influence the buying decision. The strategies must be based on what we will call External Success Criteria (ESCs). ESCs will vary from market to market, but will always be the perceivable factors that influence the buying decision. Illustrations may be price, reliability, brand name, the firm’s overall reputation, or perceived quality.

For the firm to meet the appropriate ESCs, and hence make the sale, it needs to be able to deliver its products or services on the basis of certain internal competencies, i.e. to meet certain internal success criteria or ISCs. Illustrations of ISCs may be good cost control systems, an innovative R&D department, an effective sales and marketing capacity, excellent quality control and so forth.

Of Porter’s generic strategies, Cost Leadership is KC based, Differentiation is ESC based, and Focus is neither, being merely an identification of the issue of how broadly to compete in terms of market segments.

Generic strategies can be more consistently restated on the basis of ESCs, then, as above, namely:

1. Better but good value. This option may allow premium pricing depending on market conditions (Boxes 2 and 3 in Figure 2).

2. Cheaper, i.e. priced lower than (1) but perceived as acceptable quality given the price differential (Box 4 in Figure 2).

3. Better and cheaper (Box 1 in Figure 2).

Figure 2 shows the strategic options available. If we look at the nine-box matrix relating perceived use value to price, the following conclusions emerge:

Only Box 1 represents an unassailable strategy, since it presents the best combination of perceived use value and price. This should lead to high market share. Whether the firm can reap the benefits of higher share would depend on its ability to manage costs

All other boxes are losers. Box 5 has no competitive advantage, since it is dearer than Box 4 and inferior on use value to Box 2. However, it may attract some market share due to customers with incomplete information, the inertia of brand loyalty, or if no players have exploited Boxes 1, 2 or 4. Box 6 is beaten by Boxes 4 and 5 on price and by Box 3 on use value. Box 7 is as cheap as Boxes 1 and 4 but of inferior use value. Box 8 is similarly inferior but more expensive, and Box 9 is the worst box of all being both expensive and of low perceived use value.

Given the variability of particular circumstances, the subjectivity of use value, and consumers’ real or psychological budgetary constraints, other boxes may also be viable, but some are clearly not so.

In conclusion, therefore, only Box 1 wins on all counts. However, in particular circumstances there may be sales to be made by competitors in Box 2 (the average priced differentiator), Box 3 (the premium priced differentiator), and Box 4 (the low priced ‘budget’ item), and even Box 5 the average priced average quality product without competitive advantage.

Box 2 is the box where a ‘better’ product is offered The matrix can be illustrated by reference to the car

PERCEIVED VALUE

HIGH

AVERAGE

LOW

1

Better and

Cheaper

Fleets for

2

Better

(Rover 400)

3

Belter but

Expensive

(Volvo 740)

boxes 2 or 3

4

I 5

I 6

Cheaper

(Proton)

Avenge

(Ford

Sierra)

AWXge

Value but

Expensive

I I

’ I 8 I 9 Poor Value

and

Cheap

Poor Value

and

Poor Value

and

Average Expensive

Price

LOW AVERAGE HIGH PRICE

lgure 2 An Extended Generic Strategy Matrix

at only an average price, and as such has obvious market share if not profitability attractions.

Box 3 is the high quality offering, where a ‘better’ product is offered at a premium price. This is Porter’s differentiation strategy. It may appeal to a smaller segment of the market than Box 2, prepared to pay extra for the added perceived use value offered.

Box 4 is the box for the player who intends to compete on price. His product is as good as the industry average but priced lower. On his ground no-one can beat him, although Box 1, which beats everyone, has a better product.

496 EUROPEAN MANAGEMENT JOURNAL Vol 10 No 4 December 1992


industry. It must refer to a coherent segment of demand to be useful; thus the same consumer may realistically be regarded as willing to consider purchases in any box, if he perceives the purchases to meet his needs and his budget. Let us call it the medium price family saloon segment.

Better at Low(er) cost

BETTER

t

CHEAPER

The il,lustrative marques are intended to be representa- ti\,e of possible opinions of a would-be buyer, not of the author’s views. Thus Box 5 may include an average priced average quality Ford Sierra. A Proton may be in Box 4; the Volvo 740 would probably find itself in Box 3, and Box 2 might contain the new Honda-influenced Rover 400 series. Box 1 would, however, be difficult to fill, since car manufacturers with high quality capability and low costs would probably still prefer to premium price to avoid the risk that ignorant consumers would identify price with quality. Any low cost Box 2 or even 3 marque would, however, willingly enter Box 1 for volume fleet purchases in times of slack demand.

. Inovation . Cost Control

. R&D . Economies of Scale and scope

. Knowhow . %Kience

. Patents . Low cost Input

. Location . Technology

The remaining boxes should be empty, except for transitory inhabitants, as their qualities would not generate sufficient sales to preserve their existence.

. Brands

Figure 3 External and Internal Success Factors Help Deliver Strategy

In order to implement any of the above strategies the firm needs to meet the appropriate ESCs. But to do this it needs to be internally organised to establish the relevant ISCs, e.g. to achieve profitable competitive prices (an ESC) you need good cost control systems (an ISC). It should be noted that ESCs and ISCs are not the strategy as such. But ISCs need to be established and ESCs delivered to enable the strategy to be successfully operated.

ments can be made that will militate towards effective strategy implementation. The prime issue then is not which strategy to adopt, but how most effectively to operationalise the only sustainable strategy, low cost differentiation, which enables the firm to compete through higher perceived use value, and also on price, if the circumstances demand it.

Thus low cost ISCs are needed to achieve a cheaper strategy (ESC), and these may be founded on a variety of conditions as shown in Figure 3, e.g. good cost control, economies of scale, economies of scope, experience curves or superior technology effects, or low cost imputs like raw materials or labour.

Organisational Implications

Figure 3 illustrates how differing ISCs may apply to the better and the cheaper strategies. To achieve a better strategy (ESC), ISCs are needed amongst which may be capacity for innovation, specific know-how, patents, location, brand names, or even distribution advantages.

Here we move to organisational structure considerations. At a simplistic level it is suggested that organisations involved in the mass production of commodity products need structures in which efficiency is the watchword, with standardised procedures, de-skilling of operations where possible, and stringent cost control.

But neither of these strategies can guarantee sustainable competitive advantage, as both are vulnerable to the competitor well equipped with the requisite competen- ties to meet ISCs for both strategies in high measure. The determined pursuit of the combined Strategy (Box 1) may be the reason why so many Japanese companies have succeeded against Western ones in automobiles, electronics and elsewhere. ‘The Japanese . . . competitive edge rests on both innovation and efficiency’, (Abernathy et al 1981).

Correspondingly, where fashion items, most services, or highly differentiated specialist products are concerned, the organisation should be flexible, and allow for the creative, and hence unpredictable input necessary to achieve success.

This paper proposes that to implement the successful low cost differentiation strategy, the unit of organisational analysis should be not the SBU but the value chain activity (Porter 1985). As an illustration let us consider the value chain of a medium sized insurance broking firm. This may be depicted as shown in Figure 4 in a value chain format appropriate to its primary and support activities.

There is no choice at this level, if genuine sustainable The strategy of the firm may be assumed to be to create competitive advantage is sought. Ceferis paribus the low the most innovative offerings to meet the specific needs cost differentiator must win, if organisational arrange- of its target customers, and to provide them at a very

EUROPEAN MANAGEMENT JOURNAL Vol 10 No 4 December 1992 497


management

Human Resourqes Technology

Finance underwritina -

-

0) c .- 2i Y

t

5

-I-

L

T

i

i

T -I-

I

T

I I

j_

Figure 4 Value Chain of an Insurance Broker

competitive price. In order to implement this strategy most effectively, each value chain activity will need to be considered independently and differently, from a structural and cultural standpoint.

The purely administrative functions where efficiency, low cost, and standardisation are key criteria should be organised accordingly, using appropriate efficiency orientated approaches. This would apply to the activities concerned with buildings and other fixed assets, administration, and policy and claims administration, collecting the premiums and in sales administration.

A more flexible structure would need to operate, however, in the areas of marketing, where new service provision originates, and also in enquiry generation, actually closing the sale and reselling, and in approaching the issue of taking the risk and placing it. Of the support activities, human resources should probably follow the flexible pattern, since it needs to cope with the wide variety of human needs, and technology should have an ambience that emphasises the value of change and development. Procurement on the other hand would need the efficiency and cost criteria to dominate.

This leaves only infrastructure. The importance of this activity, which includes general management, and structures and systems, is that it has the function of creating an SBU-wide culture of ‘gestalt’ over and above the separate activities. This function needs to establish a set of common values for the SBU, to institute appropriate coordinating mechanisms across the disparate value chain activities, and to conduct make- or-buy decisions within the SBU where particular

activities might seem incongruent with the gestalt of the whole.

The make-or-buy decision is an important one in relation to the overall firm gestalt. The decision should be made on the basis of three key considerations;

How congruent is the activity with the firm‘s overall gestalt? For example, mechanistic or highly repetitive activities might be incongruent with the gestalt of a ‘creative’ firm. How good is the firm at carrying out the activity compared with the industry best? If it is very good, the activity may represent a ‘core competence’, and as such may be an activity on which the firm should base its claims to competitive advantage. How important is the activity from a strategic viewpoint? It would be unwise to subcontract a strategically important activity, e.g. a unique technological process, even if the firm is not yet very competent in using it.

Subject to an evaluation based on these criteria, a firm might increase the consistency of its infrastructure gestalt by subcontracting or buying-in activities that would otherwise clash with that gestalt.

‘Divestment may be a means of dealing with cross- organisational incompatib~ities~ (Frank 1984). Marks and Spencer’s policy in maintaining a consistent retailing gestalt by subcontracting a closely inspected and quality controlled manufacturing function, is a classic illustration of this approach.

In our insurance broker example, many activities could possibly be carried out on a buy-in basis e.g. printing



activities, training, or the use of independent wholly commissioned sales agents instead of a salaried sales force. Secondly, the issue of whether to take the risk oneself, or to place it on the market is a perennial issue for a successful insurance broker contemplating whether to convert into a full insurance company for the potential up-side profit potential. Considerations of key competencies and perceived risk profile must be key to resolving this issue, but may change with time and circumstances.

In order to achieve complete congruity of the organisational gestalt it may be decided to sub-contract all activities that do not fit. Alternatively if, say, 90% of the activities in the value chain fit a particular type of organisation, e.g. the ‘efficiency’ mode, then the organisation should establish an appropriate gestalt for efficiency, and make allowances for the activities that do not fit this mode.

If, however, the activity balance is split more evenly, say, between creative and efficiency orientations, then activities with similar needs might be grouped together organisationally under appropriate leadership, and coordinating mechanisms set up to ensure smooth working.

Thus by carrying out organisational analysis at a value chain activity level, rather than an SBU level, the apparent problems of the potential conflict between ‘creative‘ and ‘efficient’ organisations may be mitigated. The creation of organisation structures is a subtle art, and the apparently simplistic requirements of ‘cost’ as opposed to ‘differentiation’ strategies, should not be allowed to prescribe gestalts that limit the establishment of sometimes complex and mixed strategies.

Conclusion In conclusion, this paper suggests that Porter, in his thtaory of generic strategies, gives us a false choice between a cost and differentiation orientation. Only the low cost differentiation strategy with ISCs capable of establishing both successful differentiation at low cost operation capable of delivering, if necessary, low prices, and thus able to achieve ESCs of both cheaper and better can truly give sustainable competitive advantage.

It is proposed that the firm’s organisation structure can be adapted on a value chain activity basis, rather than at an overall business unit level, and thus a structure can be set up which operates differentially by activity, but is coordinated by management to realise the effective low cost differentiation strategy necessary to achieve and maintain sustainable competitive advantage.

References Abernathy, W.J., Clark, K.B., and Kantrow, A.M. (1981) The

New Industrial Competition, Harvard Business Review. Cronshaw, M., Davis, E. and Kay, J. (1990) On Being Stuck

in the Middle or Good Food Costs Less at Sainsburys. Working Paper, Centre for Business Strategy, London School of Business.

Dess, G.G. and Davis, P.S. (1984) Porter’s Generic Strategies as Determinants of Strategic Group Membership and Organisation Performance. Academy of Management Journal, Vol. 27, No. 3, pp. 467-488.

Frank, R.H. (1984) Are Workers Paid their Marginal Products? American Economic Review, pp. 549-71.

Hill, C.W.L. (1988) Differentiation Versus Low Cost or Differentiation and Low Cost: a Contingency Framework. Academy of management Review, Vol. 13, No. 2, pp. 401-412.

Karnani, A. (1984) Generic Competitive Strategies - an Analvtical Avvroach. Strategic Management Journal, Vol. 5, PI;. 367-%O.

McNamee, P. and McHugh, M. (1989) Competitive Strategies in the Clothing Industry. Long Range Planning, Vol. 22, No. 4, pp. 63-71.

Miller, D. (1988) Relating Porter’s Business Strategies to Environment and Structure: Analysis and Performance Implications. Academy of Management ~oumal, Vol. 31, No. 2, pp. 280-308.

Miller, D and Friesen, P.H. (1986) Porter’s Generic Strategies and Performance: an Empirical Examination with American Data. Part 2: Performance Implications. Organisation Studies, Vol. 7, No. 3, pp. 255-261.

Murray, A.I. (1988) A Contingency View of Porter’s Generic Strategies. Academy of Management Review, Vol. 13, No. 3, pp. 390-400.

Porter, M.E. (1980) Competitive Strategy, Free Press, New York. Porter, M.E. (1985) Competitive Strategy, Free Press, New York. Skivington, J.E. and Daft, R.L. (1991) A Study of

Organisational ‘Framework’ and ‘Process’ Modalities for the Implementation of Business-Level Strategic Decisions. Journal of Management Studies, Vol. 28, No. 1, pp. 45-68.

White, R.E. (1986) Generic Business Strategies, Organisational Context and Performance: an Empirical Investigation, Strategic Management Journal Vol. 7, pp. 217-231.

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Generic strategies and congruent organisational structures: Some suggestions